As the yen skyrockets to 15-year highs, despite the confirmation of an almost zero-rate interest policy by the Bank of Japan, it’s fairly clear that currency management isn’t a predictable business for plan sponsors with international assets.
Currency management was the topic of the most recent Canadian Investment Review debate.
Is active hedging the answer? Thanos Papasavvas, head of currency management at Investec Asset Management thinks so, for two reasons. The first is that the orderly world of Bretton Woods is gone. Thus, “in the fixed exchange rates world of the 1950s and 1960s, currency investing was neither necessary nor worthwhile. However, over the last 15 to 20 years, it has developed greatly by way of cross-border portfolio exposure management and as a stand-alone way to manage assets.”
On top of that, currency investors have different reasons for their investment decisions. “Many market participants do not try to maximize their returns when trading currencies, meaning currencies may trade away from their fair value for prolonged periods of time.”
But is active management worth the cost?
Jay Moore, managing director at State Street Associates, thinks otherwise. “[W]hile there is a strong argument in favour of direct investment to currency alpha strategies within a diversified portfolio, I would argue that investors should primarily concern themselves with existing currency risk rather than embarking on a quest for new sources of alpha.”
What’s key here is the likely current exposure of pension funds to international securities. “The primary challenge to active overlay programs in Canada is that these programs impose constraints that limit investment opportunities to exposures that are highly concentrated within USD, EUR, GBP and JPY, and which make up roughly 80% of total foreign exposure.”
As a result, pension plans are constrained from seeking alpha, say in emerging markets, because they are heavily benchmarked to the developed world in their asset allocation. “Until benchmarks are moved away from a market-cap weighted (or similar) allocation methodology to international investing, active currency overlay will continue to be handicapped by the concentration of currency exposures,” Moore says.
So, a passive or an active currency allocation? Debate moderator Michael Lewis, a principal at Mercer, concludes that “we have seen that currencies should be part of the investment decision-making process from the strategic allocations through to implementation…. the discussion of hedging or active currency management may ‘paralyze or polarize’ a board of trustees.”
Paralyze or polarize? Not for participants in the debate.
They voted 57% in favour of active currency hedging.